August 29, 2009

At my place of work I have the option of putting a % of my pay towards an Employee Stock Purchase Plan or ESPP. With the plan I can put up to 10% of my pay into a fund and then every 6 months I get to buy stock at a 15% discount. Not only that but they also let me buy at the lower of the price of the start or the end of the period. So if the stock starts at $10 at the start of the period and ends at $12 at the end of the period then I get to buy it at 85% of the lower of the two or $10. I'm also allowed to flip the stock immediately and cash in the profits. I do the ESPP at work to the max then sell it immediately.

Many companies have ESPP plans nowadays. How the ESPP works will differ from one company to another. You may or may not get to buy at prices from the start of the period. Some companies make you hold the stock for a period of time before you can sell.

Should you do it?

Usually I think the answer is YES. A 15% guaranteed benefit is nearly impossible to beat.

You could even borrow money on a credit card to pay for it and end up coming out ahead. I wouldn't really recommend that, but it illustrates how good of a deal ESPP's are.

So generally I think the answer is YES you should do ESPP as much as you can.

Reasons You might Not want to do ESPP

1. If your company makes you hold the stock for a long period of time. If they lock you in for 1-2 years and won't let you sell the stock before then then I would look at this as a problem. Your company might be doing fine and then start to go downhill within 1-2 year period.

2. If your company is financially unstable. I really wouldn't want much of my assets locked into a stock for a company that is on shakey financial ground and might even go bankrupt. Imagine if you had ESPP money tied up in Lehman Bros. or Enron before they collapsed.

3. If the benefit isn't that big. My company does 15%, but the discount rate can vary. If your company only offers a 5% discount then that isn't very compelling to me and you may as well just put your money in savings and keep it liquid.

Should You Flip or Hold

Personally I think flipping ESPP shares is the better option. When I say 'flipping' the shares I mean selling them as soon after you buy them. I'd rather cash in that easy 15% profit than hold the stock and gamble that it will go up further. I also don't think its a good idea to hold too much of your own company's stock at any given time.

What if you cant afford it?

Find a way. A lot of people live paycheck to paycheck and can't see how they could live without 10% of their paycheck. I wouldn't look as an ESPP as living without 10% but instead making a 15% guaranteed profit in 6 months. So, figure out a way to make it work. If you have to shuffle around your money or even accumulate some short term credit card debt it should be worth it to get that extra 15% gain.

Be careful with taxes

The tax implications on an ESPP can be tricky. I'd recommend you talk to a CPA or at minimum read up on how ESPP is treated in taxes.

2 comments:

If you sell the stock immediately (i.e., flipping), you will owe taxes on the difference betweeen your discounted purchase price and the market price on the date of purchase. So if you purchase the stock at the discounted price of $8.5 (15% discount from the $10 start price), while the market price is $12. You will owe taxes on $3.5 of ordinary income. The taxes get more complicated and more favorable if you hold the stock one year from purchase and two years from enrollment/grant.

Assuming this is a tax qualified ESPP, there is no withholding and no Medicare or Social Security tax. Just be prepared to owe the taxes with your tax return or pay estimated taxes.

As for strategy on whether to partcipate or not, and whether to hold the shares, you also want to consider whether you are maxing out on your 401(k) and does it make sense to if you intend to take distributions from it soon. For a useful two-part article series on ESPP strategy, which analyzes whether to flip or hold, see the ESPP Advanced section on www.myStockOptions.com.

As Bruce points out there is a tax benefit if you hold the shares longer. The reason I do not do that personally is that I do not want to be too heavily invested in my employer and I don't want to take the risk of the stock going down or staying flat for those 2 years. But for others it might make sense to hold the stock for 2+ years.

I would just caution against getting too high of a % of your total assets in your employer's stock. I wouldn't want over 5-10% of my assets in my employer stock. If you get too much ownership in your employer then you can get hit with a double wammy if they go under and you end up losing your job and seeing your investments in their stock crumble in value.

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